Why The Fed, by itself, cannot deliver a sustainable recovery?
A 6 part series
Part 1: Setting the scene
1.
INTRODUCTION
America’s
economic revival is hindered by a number of dubious notions, or untenable convictions. Chief among them is overreliance on monetary policy as
a solution to all economic problems, especially restoring growth and employment
after a recession hits.
Six years after the Great Recession of 2008, despite the
extraordinarily low interest rates bolstered by aggressive Quantitative Easing
(QE) for an unprecedented $4.5 trillion of bond purchases by the Fed, the
recovery still looks curiously tentative, if not anemic.
· Growth in 2014 was under 2.5 %, even if the second half of the year the economy expanded at a
surprising 3.5% as to compensate for a measly 1.3 % growth in the first half.
There are still too many unknowns to declare the last 2 quarters as growth-rate a trend setters.
· Labor participation rate under 63% is at a 36 years low, pointing to
about 10 million less people with jobs relative to 2008 when the recession was
declared. This “slack” in the labor force, despite an unemployment rate which finally
dropped below the target 6 % in the 4th Q of 2014, continues to
trouble Fed’s chair Janet Yellen who described her concern at the most recent
Jackson Hole conference.
· Inflation is unresponsive and
tracking below 2% despite the unparalleled QE programs pumping many $ trillions
of liquidity into the capital markets. Alas, the outdated and restrictive way
by which inflation is measured may well be masking a looming problem: the
unavoidable impact of both the record rise in stock prices and the large
appreciation in house prices since 2009 is omitted from the inflation index.
·
Consumer spending
which accounts for more than 2/3 of U.S. economic activity is still inexplicably
muted, despite the cheapest borrowing rates in recent memory and the vast
household debt reduction, from 98% of GDP down to a sustainable 81% now. More
mysteriously, rising stock markets, historically associated with increased
household outlays, have this time failed to stimulate higher consumer spending.
· Deleveraging, an imperative for
financial stability, is still a mixed-bag: while private-sector indebtedness
has decreased to historically sustainable levels of around 80% of GDP, gross
public debt, now over 105% of GDP, is a daunting obstacle if renewed
recessionary fears do indeed engender increased government spending.
Even more unsettling is that the Great Recession of 2008, which
is still playing out with an abnormally lackluster recovery, still faces the
same and yet unanswered question that followed the 2001 crisis: to what extent
can expansionary monetary policy –
undeniably correlated with asset and
credit “bubbles” – also repair the
damage that it helped create ?
1.
TAKING STOCK OF THE CURRENT
SITUATION
2.1 Discarding some misconceptions first
Political discourse in the US projects unmistakable signs of
confusion when references are made to either John Keynes or Milton Freedman. In
the first case, Keynesian economics is criticized because of the incremental
burden that increased government spending imposes on taxpayers; while in the
second case, Milton Freedman’s monetarism is feared because of the inflationary
risk that increasing money supply poses in support of a faltering economy. Both
theories contain so many nuances and conditions that, in the absence of correct
contextual clarity, condemning them is not difficult to do. Yet, the reality is
quite different.
No, since 2008, the US economy has witnessed neither an alarming
Keynesian rise of excessive government spending, nor an inflationary overdose of
monetarist money supply.
We have witnessed instead, in the first case, record government
deficits resulting from shortfalls in tax receipts that economic recessions
bring – this time, further aggravated with misguided tax-cuts already in place
– and, in the second case, a daring experiment with monetary policy which –
fortunately for incredulous politicians and the public at large – succeeded in preventing
the insolvency and decomposition of the US banking system.
To be clear, a massive increase of Keynesian government spending
to bolster economic output – by targeting public works for instance, as was
suggested by Paul Krugman and others – has not yet taken place amid our
political stalemate. And, inundating the economy with excessive money as to
“inflate the deficit away” through currency debasement has not taken place either;
the Fed’s swapping of cash with bonds through QE has indeed increased the
monetary base, but not the kind of money supply associated with massive
devaluations.
But now here we are, six years later, with an uncertain economy
and a tentative job market, wondering whether and how the anticipated but still
elusive growth will suffice to eliminate chronic government deficits and a
threat of deflation, both of which are stubbornly present.
